Innocent Spouse Relief: Do You Qualify?

Tax law on a table. Taxation concept.

It’s one thing to owe back taxes and penalties because of your own mistakes. But when your spouse filed on your behalf, sometimes their errors or omissions can come as a shock. When your current or former spouse’s conduct leaves you on the hook for unpaid taxes, you may be able to obtain Innocent Spouse Relief to forgive for some or all of the debt. The biggest question is whether you qualify.

Innocent Spouse Claims Ignorance of Husband’s Business Income

Mrs. Soler was the primary wage earner for her family and her two children. As a manager and clothing designer, she earned an annual salary of $160,000. Her husband was a stay-at-home father and operated a consulting business and a real estate business between 2012 and 2014. He also prepared and filed the family tax returns, reporting the family income, including his business income and expenses. He reported net losses for his businesses in 2012 and 2013, and a net profit of just $1,762 in 2014.

In 2015, the IRS reviewed the Solers’ tax returns because of issues with Mr. Soler’s Schedule C business income and expense reports. After interviewing only Mr. Soler, the IRS issued a notice of deficiency and accuracy-related penalties for each year. The IRS also determined that the Solers had failed to report income distributions from their retirement accounts. This resulted in a second notice of deficiency and penalty. After the family filed for bankruptcy, Mrs. Soler filed a Request for Innocent Spouse Relief, claiming that the tax errors had been her husband’s fault. After the IRS determined she did not qualify for Innocent Spouse Relief, Mrs. Soler filed a lawsuit in the U.S. Tax Court asking the judge to reach a different conclusion.

What is Innocent Spouse Relief?

Generally, when married couples file joint tax returns, they are jointly and severally liable for any tax liability due. That means the IRS can collect 100% of the tax deficiency from either spouse. Innocent Spouse Relief asks the IRS to ignore that joint liability and only pursue collections from the spouse at fault for the tax error.

What Does it Take to Qualify for Innocent Spouse Relief?

There are three ways you can qualify for innocent spouse relief:

  1. Full or partial relief for married filers under 6015(b)
  2. Proportionate relief for legally separated or divorced spouses under 6015(c)
  3. Equitable relief for individuals facing financial hardship under 6015(f)

Mrs. Soler was still married to Mr. Soler when she filed her case, so she only sought Innocent Spouse Relief under the first and third options.

Full or Partial Innocent Spouse Relief under Section 6015(b)

To qualify for innocent spouse relief under Section 6015(b) you will have to show:

  • A joint tax return was filed for the year in question
  • There was an understatement of tax caused by the non-requesting spouse’s error
  • The requesting spouse (you) didn’t know or have reason to know of the understatement of tax
  • It is inequitable to hold you responsible for the tax deficiency
  • You requested relief on time.

In Mrs. Soler’s case, the big question was whether she should have known about her husband’s claimed business losses. She claimed that she did not believe her husband was working at all during the period in question. She thought her mother-in-law was giving the family gifts to make up for the short-fall in their income. The Court agreed that she had no actual knowledge of the income, but questioned whether she should have known or inquired based on the household finances not adding up.

In deciding whether a requesting spouse had reason to know of an understatement, the courts look at all the facts and circumstances, including:

  • The spouse’s level of education
  • Their involvement in the family’s financial affairs and business
  • Unusual or lavish expenses given the family’s past income
  • The non-requesting spouse’s evasiveness or deceit about the family finances
  • Whether the requesting spouse had satisfied her duty of inquiry into facts showing an understatement may exist

The fact that the requesting spouse didn’t read the tax return before signing it is generally not enough.

The Court said, as a college educated person and the primary income earner, Mrs. Soler should have known there was a problem with her tax returns. Since she believed Mr. Soler was not working at all, the presence of Schedule C forms should have raised questions for her. The family’s financial stress during the years at issue also should have caused her to inquire about where the business losses were going. Because she didn’t, the Court said she had constructive knowledge of the tax return’s contents and reason to know about the understated taxes. In 2015, when Mr. Soler failed to disclose the retirement account disbursements, the IRS was already investigating the family and Mrs. Soler had briefly met the investigator. The Court said, if nothing else put Mrs. Soler on notice that she should be reading her tax returns closely, the audit should have made it clear.

Equitable Relief Under 6015(f)

Section 6015(f) allows for innocent spouse relief even when subsections (b) and (c) don’t apply if and it would be inequitable to hold the requesting spouse responsible for the tax debt given all the facts and circumstances. To qualify for innocent spouse relief under this section, you must usually prove:

  • A joint tax return was filed for the year in question
  • There was an understatement of tax caused by the non-requesting spouse’s error
  • Relief is not available under a different subsection
  • The spouses didn’t transfer assets as part of a fraudulent scheme
  • The non-requesting spouse didn’t transfer disqualified assets to you
  • You did not knowingly participate in filing a fraudulent tax return
  • You requested relief on time

These are the threshold conditions for qualification. The IRS agreed that Mrs. Soler met these threshold conditions. Then the Court will consider whether you are eligible for streamlined relief, or qualify under the full facts and circumstances test. Streamlined relief is reserved for cases where you:

  • Are no longer married to the non-requesting spouse
  • Would suffer economic hardship without relief
  • Lacked knowledge or reason to know of the understatement

Because Mrs. Soler was still married to Mr. Soler, she was not entitled to streamlined relief. Instead, the Court applied the full facts and circumstances test, considering her:

  • Marital status
  • Economic hardship, making the requesting spouse unable to pay reasonable basic living expenses
  • Knowledge or constructive knowledge of the payment, unless the non-requesting spouse was abusive or financially controlling
  • Legal obligation to pay the tax due to a divorce decree or other legally binding agreement
  • Benefit derived from the understatement or underpayment, including a lavish lifestyle, luxury items, or expensive vacations
  • Compliance with income tax laws, including filing separately after the understatement is discovered
  • Mental and physical health

Here, Mrs. Soler was relatively healthy, still married to Mr. Soler, still filing her taxes jointly, still earning more than enough to pay basic living expenses, and still legally obligated to pay the tax debt. The only factor weighing in favor of innocent spouse relief was that she had not received a benefit from the underpayment of taxes. Thus, the Court determined she did not qualify for Innocent Spouse Relief and would remain jointly liable for her husband’s underreported business income taxes and penalties.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions about whether you qualify for Innocent Spouse Relief, contact Joe Viola to schedule a consultation.